Canada: Employee Share Ownership Plans: Are they Right for Your Company?

Last Updated: September 17 2015
Practice Guide by Duff & Phelps

Many business owners and executives consider implementing an employee share ownership plan (“ESOP”) within their company as a means of attracting, retaining and motivating employees. While the benefits of a properly designed ESOP can be significant, there are potential risks and issues that should be carefully considered before they are introduced.

How Does an ESOP Work?

In essence, an ESOP is an arrangement whereby certain employees of a company can become shareholders if they meet the specified criteria. Qualifying employees are either granted shares or an option to buy shares in a company at a specified price. The acquired shares usually are held until the employee leaves the company or a specified liquidity event occurs, such as a sale of the company to a strategic buyer or an initial public offering.

There is a considerable amount of flexibility in how an ESOP is designed. Some of the basic considerations are summarized in Exhibit 1.

Exhibit 1
ESOP Considerations


ESOP Considerations

The first issue to be addressed when designing an ESOP is to determine the criteria for participation. In this regard, there are two basic schools of thought. The first option is to restrict ESOP participation to a handful of key employees. This can be a way of recognizing and incentivizing select individuals who are viewed as critical to the long term success of the organization, and making those individuals feel distinguished within the company. However, it can also lead to the feeling of two classes of employees within a company – those that are ESOP eligible and those who are not. The other basic alternative is to extend the ESOP to all employees that meet certain basic criteria, such as having been employed with the company for a specified period of time. In this case, the magnitude of an employee’s participation in the ESOP program often varies based on factors such as job title and compensation, so that senior management employees are rewarded more than individuals who occupy administrative and junior positions. This approach allows for the benefits of the ESOP to be widespread, but requires a larger pool of shares be made available, thereby diluting the interests of existing owners. A company-wide ESOP can also be more costly and time consuming to administer.

Another key consideration when designing the ESOP program is to determine the size of the ESOP pool. That is to say, what proportion of ownership are the existing shareholders prepared to give up in favour of ESOP participants? The obvious trade-off is that a greater degree of ownership participation creates added incentive, but existing shareholders experience greater ownership dilution. Business owners and executives should also remember that an ESOP pool will grow over time, as new shares are issued each year. Therefore, if shares representing 4% of the company are issued pursuant to an ESOP each year, then the existing owners will have diluted their interest by 20% within a 5-year period. At that point, it may be difficult to modify the ESOP to slow down the rate of dilution, as employees will have established expectations.

It is also necessary to consider whether the ESOP will take the form of shares or options that can be exercised for shares. In conjunction with this decision is whether shares offered will be given to employees, or whether employees must acquire the shares at their prevailing fair market value. Requiring employees to acquire shares can be difficult for those individuals with limited financial resources – even if attractive payment terms are offered. Options are attractive because the price paid for the shares (as determined pursuant to strike price of the option) usually takes place concurrently with a liquidity event, so the employee is not out-of-pocket. However, if the value of the shares declines, then the options may be “under water” and provide little incentive. Having employees actually own shares can help to solidify retention, since they will have made a monetary commitment. Some ESOPs are designed to include both an element of physical shares and options in order to balance the pros and cons of each alternative.

Establishing the characteristics of the ESOP shares is another key decision. In some cases, the shares issued pursuant to an ESOP have different rights and privileges than those held by the existing shareholders. For example, ESOP shares may be non-voting or having limited voting rights. While this can help to ensure that the existing owners retain voting control in the organization, it can make employees feel as though they are receiving lesser economic value. Where the ESOP shares do have voting rights, it is also important to consider whether and how ESOP participants will be represented on the company’s board of directors. A properly structured shareholders agreement that sets out the rights, privileges and obligations of all shareholders within a company is a critical component of any ESOP.

Finally, the provisions and restrictions governing the liquidity of the ESOP shares must be clearly established. In most cases, the shares received pursuant to an ESOP cannot be freely traded, and employees must wait for a “liquidity event” in order to get paid for their shares. Where the liquidity event involves a sale of the company to a strategic buyer or an initial public offering, then payment for the ESOP shares is a non-issue, since external financing is available. However, liquidity events are more problematic when the company must finance the purchase of its own ESOP shares, such as when an employee leaves the company (most privately held companies do not want former employees holding shares). In this regard, many ESOPs are designed such that, in the event of a voluntary departure from the company, the redemption price is subject to a discount from what their value may otherwise be. This serves as a type of penalty to an employee who leaves the company and wants to cash in.

What are the Major Benefits, Risks and Issues of an ESOP?

The major benefits, risks and issues relating to ESOPs are summarized in Exhibit 2:

Exhibit 2
Major Benefits, Risks and Issues of an ESOP

Major Benefits:

  • ESOPs help a company in attracting, retaining and motivating key employees. This makes ESOPs particularly attractive in industries where specialized skills or knowledge are essential (such as high technology);
  • ESOPs can help in reducing cash compensation paid to employees, which can be critical for smaller and rapidly growing companies that need to preserve cash in order to finance expansion initiatives;
  • ESOPs help to align the interests of employees with those of the business owners. A properly structured ESOP can encourage employees to think like entrepreneurs, and find new ways to grow the company and reduce costs. In particular, an ESOP can help to alleviate employee concerns about a liquidity event that involves a sale of the company to a strategic buyer, since the employees stand to benefit financially;
  • ESOPs can help in attracting financing. Many commercial lenders and private equity firms perceive that there is less risk in dealing with a company that has a well designed ESOP, since it can help ensure that key employees are committed to the company. This is particularly the case where employees must pay for shares on their issuance (rather than receiving options) since equity injections will help to strengthen the company’s balance sheet; and
  • income tax efficiency. Properly structured, employees participating in an ESOP will only be taxed on the disposition of their shares at capital gains rates. In addition, there can be an opportunity to utilize the lifetime capital gains exemption, which means that up to $750,000 of income per employee may be received tax free.

Major Risks and Issues

  • incremental costs. ESOPs involve up-front legal, administrative and accounting costs relating to developing and implementing the plan. Once the ESOP is established, there are additional ongoing costs in terms of financial reporting and valuation;
  • additional governance requirements. Participants in an ESOP have certain rights as current or prospective shareholders within an organization. There may be a need for a formal board of directors where ESOP participants have representation. This may have an impact on the company’s strategy and key decisions. Further, an ESOP will reduce the flexibility that business owners have in terms of making discretionary payments such as bonuses to themselves and family members;
  • potential erosion of the company’s cash reserves. As noted above, where employees leave the company, the shares that they received pursuant to the ESOP usually are redeemed. Even where the redemption price is subject to a discount, the company must still finance the redemption with other internal resources. As an alternative to a redemption discount (or in addition to one), some companies pay for redeemed shares over a period of several years (normally without interest) in order to alleviate financing issues;
  • the possible de-motivating impact where share values have declined. Many companies have experienced this phenomenon in recent years with the downturn in economic conditions. Employees who acquired shares pursuant to an ESOP may feel that they were forced to overpay. Where options were granted in lieu of shares, the strike price of those options may be so far “under water” that they provide little economic incentive; and
  • possible friction among employees where not everyone participates in the ESOP. As noted above, this can create the feeling of two classes of employees within an organization.

What are the Next Steps?

Business owners and executives who are considering an ESOP are well advised to do their homework and to get sound and objective professional advice. They must be satisfied that the prospective benefits will outweigh the costs involved. Further, as much as the legal and administration costs of an ESOP can be significant, the potential consequences to a company from a poorly designed ESOP can be far worse. It is much easier to implement an ESOP than to try to modify or cancel it afterwards. Hence the need to invest the time, effort and cost to ensure that an ESOP is designed properly from the start, and that the long-term implications of an ESOP are carefully considered.

This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Contact the Author?
Click here to email the Author
In Association with
In Partnership with
Other Canada Advice Centres
Competition and Antitrust
Mergers and Acquisitions
Labour and Employment
More Advice Centers
Useful Resources
CBVs are experts in their field. The following articles and papers have been written by CBVs, several articles have been featured in various national publications.
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.